The Wrong Right Wing Stuff

I inadvertently stepped on a right wing meme back last September when I implied that Fannie and Freddie did their share in contributing to the current financial meltdown. I used figures to show that the problems in the mortgage market were occurring equally in the subprime as well as the prime market. What happened is that I said was associated with the oft -repeated Republican talking point that the CRA (Community Reinvestment Act) caused the meltdown in the mortgage. I still think that was a wild shark jump, but I was called things I won’t repeat here because of that big leap. I was channel surfing last night and heard Glenn Beck (Mr. Emotional Basketcase) repeat this nonsense yet again. So, let me use real research to put clip the right wings off of that one.

Today’s WSJ overviewed a study by the Minneapolis Fed (yes, the peer reviewed, use data kind, not the say what you want to get ratings type of study) and concluded that the CRA did not contribute to the mortgage market meltdown. Let me just add here that I worked for the Fed and the Minneapolis Fed has one of the more conservative research agendas and economists. Most famously, they’re home to Robert Lucas and Thomas Sargent’s work on Rational Expectations. These guys are freshwater economists.

At the center of much of the shouting is the the Community Reinvestment Act (CRA), a 1970s-era law that pushed banks to lend to low-income households. Some — mostly conservatives — contend that the government program, coupled with securitization from Fannie Mae and Freddie Mac, played a role in the surge in risky home lending that formed the root of the financial crisis. Liberals counter that the Fannie/Freddie/CRA argument is a red herring that tries to pin a market failure on government interference.

A report from the Federal Reserve Bank of Minneapolis took a look at data on subprime — referred to as “high-priced” — loan originations and performance at CRA-regulated lenders and their affiliates and institutions not covered by the law. Here’s one of the central findings:

In total, of all the higher-priced loans, only 6 percent were extended by CRA-regulated lenders (and their affiliates) to either lower-income borrowers or neighborhoods in the lenders’ CRA assessment areas, which are the local geographies that are the primary focus for CRA evaluation purposes. The small share of subprime lending in 2005 and 2006 that can be linked to the CRA suggests it is very unlikely the CRA could have played a substantial role in the subprime crisis.

This report doesn’t represent the first time the Fed has tried to bat down the notion that the CRA played an important role in the subprime mess. Late last year, then Fed Governor Randall Kroszner, a University of Chicago economist and former Bush administration official, echoed the findings of the report saying only about 6% of all subprime mortgages to low-income households trace back to banks that had to meet CRA standards. (Although this Investor’s Business Daily editorial is skeptical.)

Okay, so I basically spent the morning with the report over my coffee, checked the tables, the methodology, and all that good wonky stuff. I’d like to point out the two statements of clarification made by the authors because they’re very interesting and necessary. The source of the originating lender, their practices, their oversight and audit quality and the nature of their business is one factor that is very important remains central.

When considering the potential role of the CRA in the current mortgage crisis, it is important to account for the originating party. In particular, independent nonbank lenders, such as mortgage and finance companies and credit unions, originate a substantial share of subprime mortgages, but they are not subject to CRA regulation and, hence, are not directly influenced by CRA obligations. (We explore subprime mortgage originations in further detail below.)

The CRA may directly affect nonbank subsidiaries or affiliates of banking institutions. Banking institutions can elect to have their subsidiary or affiliate lending activity counted in CRA performance evaluations. If the banking institution elects to include affiliate activity, it cannot be done selectively. For example, the institution cannot “cherry pick” loans that would be favorably considered under the law while ignoring loans to middle- or higher-income borrowers.

Another equally important factor is how on earth do you get causality from something that happened 30 years ago and a shock in today’s market? This is the one question that I never hear any of the wingers address. The study addressess it straight on in the introduction.

The current crisis is rooted in the poor performance of mortgage loans made between 2005 and 2007. If the CRA did indeed spur the recent expansion of the subprime mortgage market and subsequent turmoil, it would be reasonable to assume that some change in the enforcement regime in 2004 or 2005 triggered a relaxation of underwriting standards by CRA-covered lenders for loans originated in the past few years. However, the CRA rules and enforcement process have not changed substantively since 1995. This fact weakens the potential link between the CRA and the current mortgage crisis.

So, the authors directly point to the time period and the enforcement regime around 2004 and 2005. There was no relaxation of CRA underwriting standards at the time. The relaxation of underwriting standards had to come from a different source. So the authors look at a pool of loans during the relevant time and the variables of interest are basically loan originations and the type of originating institution. Here’s a link to FNMA and their criteria for producing Mortgage-Backed Securities that give institutions credit for CRA lending to give you an idea of potential loan characteristics.

Fannie Mae’s Community Reinvestment Act (CRA)-targeted Mortgage-Backed Securities (MBS) may help both originators and institutions seeking to purchase a CRA-targeted investment.

The pool data below contains informational files for certain Fannie Mae MBS that contain high concentrations of loans with household income levels that meet the low- and moderate-income definitions of the CRA. These include: pool number, rate, original term, city, state, ZIP code, county, percent median income, number of units, census tract, and low/mod income tract.

Using loan origination data obtained pursuant to the Home Mortgage Disclosure Act (HMDA), we find that in 2005 and 2006, independent nonbank institutions—institutions not covered by the CRA—accounted for about half of all subprime originations. (See Table 1.) Also, about 60 percent of higher-priced loan originations went to middle- or higher-income borrowers or neighborhoods, populations not targeted by the CRA. (See Table 2.) In addition, independent nonbank institutions originated nearly half of the higher-priced loans extended to lower-income borrowers or borrowers in lower-income areas (share derived from Table 2).

In total, of all the higher-priced loans, only 6 percent were extended by CRA-regulated lenders (and their affiliates) to either lower-income borrowers or neighborhoods in the lenders’ CRA assessment areas, which are the local geographies that are the primary focus for CRA evaluation purposes. The small share of subprime lending in 2005 and 2006 that can be linked to the CRA suggests it is very unlikely the CRA could have played a substantial role in the subprime crisis.

So, while subprime lending played a role, it appears those loans given CRA status did not play a role. Both Fannie Mae and Freddie Mac as well as other financial institutions package and sell mortgage back securities beyond those given CRA status. Again, you can refer to the Fannie Mae link which is basically a link to their monthly reporting figures. If you take month’s data, you’ll see that the CRA pool is a very limited portion of business for Fannie. This is true for Freddie also so these loans were not the ones that brought any mortgage lender down. This should put to rest the idea that the act itself, and the loans it generates, had anything to do with the current bank problems. That still leaves an entirely huge number of loans out there with different designations that need to be sliced and diced. As far as I can tell from the research being currently done, the biggest problem was due diligence between the originators and the buyers of the mortgages. The demand for volume (and compensation based on volume) completely broke down the underwriting process.

Anyway, I opened my own can of worms again, but I’m thinking this is an interesting enough study to warrant that. I will undoubtedly be plundered by all sides. But, I never miss an opportunity to show how really, really, really wrong Glen Beck can be.

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2 Comments on “The Wrong Right Wing Stuff”

This is what I am thinking, and I know squat, so I may be way off. Artificial capital generated a hyperinflated demand for housing. That is to say, people who didn’t have the means to pay off a loan were granted loans for property which by the demand such loans created, received loans which bolstered demand, and thus raised the prices. The institutions which lent the money felt safe because of the perceived worth of such properties as being financed, and felt that even loans in default would have ever increasing values, so no worries. The problem is, the values of that property were as false at the capital which financed them.

To top off all these problems, the financial institutions involved in generating the false capital which led to the housing bubble for a number of reasons thought government would underwrite whatever risks involved, so even if all the bad loans purchased lost some value, the government would step in to prop up the price of housing, or would simply cover the defaults.

Now the questions here are:

Did government financial institutions encourage loans to people who couldn’t afford them explicitly or implicently?

Did government in in some fashion lead institutions which bought tons of bad debt to believe that their activities are somehow underwritten by the federal largess?

I can’t claim certainty on any of the above presumptions, but I feel they must be true at least to some extent. One thing I do feel certain about, housing was priced beyond reason, and the housing crash is the market WORKING. It is also fine and well that those who build their wealth as a house of cards, find all the risk that such endeavors brings with them. If there is one sure sign of liberty in human endeavors, it is risk.

The aftermath of the housing bubble is probably a greater tragedy than the crash itself. For such a crash as this brings rewards, if left alone. Because of this crash home ownership, may appear to be out of reach for many more, but was an unpayable mortgage really ownership? this is but another lie in the house built upon lie after lie. The truth is, now ought to be the very best time for more people than ever to find adequate quality housing… if not for government.

In the aftermath, housing prices are returned to reason, and there is still demand. So what of all that greatly depreciated property owned by financial institutions? Rental property! To recoup their losses banks would have been turning many of these homes into rental property for much more affordable prices than we have seen in decades! Smart financial institutions could be recovering some of their losses, or even generate profit by selling homes at reasonable prices… and for sensible interest rates. This could have meant so much for people struggling in the cities, and suburbs to have a decent place to live during the housing bubble. Instead government has either financed the institutions out of the need to do such things, or simply closed the doors. So instead of benefit, much housing simply remains empty, and the ingenuity of a free people is overridden by congress… and the President.

Yes, Fannie and Freddie played a huge part and were encouraged by their oversight committees. I have a thread about their role from back in October that frequently gets attacked. Just yesterday some idiot said that I was saying that black people were the cause of the financial crisis which is such an overreach as to be hilarious. Here’s the link for THE CONFLUENCE version because it includes a lot of discussion.

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